Trading Primer

For those of you who are new to trading/investing, we wanted to put together a short primer with some important information. It may also be a helpful refresher to the experienced trader as well.

Brokerage Firms

There are numerous Brokerage Firms where you can open an account and do your trading. We’ve tried numerous ones and picking the right one is mostly a personal choice. For the type of trading we do, we don’t need a super-fast feed to the exchanges as the day-trader needs. But if you plan to purchase newly released Preferred Stocks off of the OTC market, you do need a Firm that allows that. Therefore, for most people, the large firms will work best. There are many reviews on the web where you can find current pricing and other important information to help you make your own decision. We have accounts at Chase, Schwab, Fidelity, Robinhood, and TD Ameritrade. Our main platform is TD Ameritrade in which we use their PC application called Thinkorswim. It is a very robust application and is overkill for our trading strategy but we’ve been using it for years and it works.

Most Firms have reduced their prices to under $5 a trade and many now  even offer free trades. Robinhood was the first place to offer free trades and became very popular. In the summer of 2019, Chase offered free equity trades to certain retail clients with their You Invest platform.  In September and October 2019, Interactive Brokers (IB), Charles Schwab, TD Ameritrade and others started offering free equity trades. It will be interesting to see if this becomes the new standard or if this is just a temporary experiment.

Entering Trades

There are a few important items to know when entering trades.

First is the Bid/Ask spread. You will notice two numbers on the trading platform. A Bid and an Ask. The Bid is the highest amount anyone is currently offering to Buy shares of the investment. Therefore, one can easily Sell their shares at this price. The Ask is the lowest amount anyone is currently offering to sell their shares. Therefore, one can easily Buy shares at this price. The distance between these two prices is called the Bid/Ask spread. In extremely liquid investments, the spread may only be a few pennies but for Preferred Stocks, this can be 25 cents, 50 cents, or even more. Since no one likes to overpay for purchases or sell for less than an ideal price, typically one does not like the current bid or ask prices Therefore, it would be beneficial to get filled between these two prices. That requires entering an order price somewhere near the middle using a Limit Order.

There are 2 basic type of orders; Limit and Market. One should almost never enter a Market Order as this tells the broker to fill your order at whatever the market allows. This can easily mean the price could not be what you were expecting. The best practice is to always enter a Limit Order. This allows you to set the price and you must be filled at that price or better (higher on a sell or lower on a buy). Even if you are willing to enter your order at the current Bid or Ask, always use a Limit Order as you never know what orders will come at a split second before your order and the Bid or Ask can change in an instant.

The last item we will discuss is the timeframe of the order. When you enter the order, most brokers allow you to pick the timeframe of the order. Should it expire at the end of the current trading day or should it stay in the system until it is filled. These are considered either Day or Good ‘till Cancelled (GTC) orders. That is a personal preference but typically if you want to make a buy or sell, it is good to do a GTC order as it doesn’t matter if you get filled today, tomorrow, or next week at the price you want.

Building & Managing Your Portfolio

An important part of investing is managing your portfolio. There are several important rules that we use when constructing portfolios. The most important part is diversification. This means your account should contain multiple investments, not just one. Imagine if you put 100% of your account into one holding. That means you are completely relying on that one holding. Things don’t always go as planned and if this one investment runs into a problem, that will fully affect your portfolio. If you had two holdings, then each holding can only affect half of your investment. Our rule of thumb is to never have any single investment encompass over 5% of the portfolio. This means if one company was to go fully bankrupt and the investment goes to $0, the account will have only lost 5%. If you’ve been in the stock market for any period of time, you know a 5% drop can happen in a single day!

In reality, our portfolio has over 100 holdings. Therefore, we typically have position sizes of 0.5% to 2%. We are OK with managing this many individual investments but others may be more comfortable with somewhere between 20 and 50. Everyone needs to find their own comfort level. Keeping some cash available is also a good idea. Having 5% to 10% available in cash to buy new investments at bargain prices is also a strategy that we use.

Good Luck with your trading.